It is often said, perhaps tritely at times, that it takes money to make money. In the business world, when the one or more decision makers at a given company subscribe to this view, and more particularly when they act according to it, that company may borrow money in (or at least as part of) an effort to grow the company, sustain the company, save the company, adapt the company to an ever-changing marketplace, and/or for one or more other reasons.
Typically, such a company will put this into practice by engaging in a business transaction to borrow what most would consider to be a substantial sum of money from an institution such as a large commercial bank (e.g., Bank of America® (currently headquartered in Charlotte, N.C.), JPMorgan Chase® (currently headquartered in New York, N.Y.), Wells Fargo® (currently headquartered in San Francisco, Calif.), GE Capital® (currently headquartered in Stamford, Conn.), CIT Group Inc. (currently headquartered in New York, N.Y.), PNC Financial Services Group, Inc. (currently headquartered in Pittsburgh, Pa.), and the like), though certainly there are types of lending institutions other than large commercial banks.
This type of transaction, where a company borrows money from a bank, is of course quite often characterized as the company taking out a loan from the bank, and is also quite often described as a way in which the company takes on debt. And the more debt a company has on its balance sheet (i.e., owes) at a given time, the more “leveraged” that company is said to be at that time. (Generally speaking, as is known to those in the art, a balance sheet is a comparison (at a given time) of a company's current assets to that same company's current liabilities.)
Now, it is noted that the word “leveraged” is used—in that form and in others close to it (e.g., leverage, leveraging, levered, and so on)—in many ways in many financial contexts. In the context of this written description, a statement of how leveraged a given company (i.e., their balance sheet) is at a given moment (i.e., “snapshot”) in time is generally a characterization of how (i) the magnitude of the debt the company currently owes (to, e.g., institutions such as commercial banks) compares with (ii) the magnitude of what is sometimes called the company's “intrinsic value” (which would typically be considered to include assets such as money (i.e., cash) and assets that could (at least in theory) be monetized somewhat readily) at the time that the aforementioned debt is owed.
The term “leveraged” (and its other similar forms) is also used at times in the art and herein as a descriptor not of a given company at a given moment, but as a descriptor of a transaction itself—that is, of the structure of a transaction. Thus, the greater the extent to which, as an example, an acquisition (of, as examples, a company or a piece of real property) was made with borrowed funds, the more “leveraged” that transaction is typically said to have been. So in the business world, when looking at a given whole, whether it be the balance sheet of a company, or the funds used in carrying out a transaction, or some other example, the degree to which that whole is said to be (or to have been) “leveraged” is typically an expression of the degree to which it is (or was) funded by borrowed money (i.e., debt).
Returning the reader's attention for a moment to the above-mentioned notion of a company's “intrinsic value,” this concept was roughly defined above as including both the actual money (i.e., cash) that the company has on hand, as well as the value of those of the company's assets that could (at least in theory) be monetized at least somewhat readily. To some extent of course, intrinsic value—and in some sense the broader concept of value in general—is in the eye of the beholder (or in the eye of the analyst(s), as the case may be). But generally speaking, an expression of a company's intrinsic value is an expression of the aggregate actual value of the company's current assets, including of course its value as a going concern (therefore including, e.g., the strength and value of any brand names, and so on).
Another way of characterizing an assessment of the intrinsic value of a company is that it involves setting aside for a moment the fact that the company may have taken on one or more (perhaps significant) debts, and focusing instead on “what's good” about the company at the moment—in other words, focusing on the assets and not on the liabilities. Such assets may include one or more of the examples already given, and may also or instead include factories, equipment, accounts receivable, and/or one or more other types of actual assets.
So, putting some of these concepts together, a statement that a company's balance sheet at a given time is “highly leveraged” is in essence a statement that the company currently owes a lot of money relative to the amount of money (e.g., cash) that the company currently has and could (at least in theory) readily generate by selling everything (other than its cash, of course) that it has and is, including any factories, equipment, intellectual property, etc.
Now, if a company is, for one or more reasons, deemed by one or more people, entities, and/or institutions that are making such an assessment as being sufficiently unlikely to pay off (e.g., sufficiently unlikely to be able to pay off) a given debt the company has taken on, that debt is typically and herein described as being “distressed.” That is, that debt is known as “distressed debt,” and from the perspective of the original lender—or from the perspective of the current owner of the debt in cases where the current owner is not the original lender—is no longer the asset (i.e., revenue stream of regular payments) it was once thought to be.
As such, it often occurs that, for the right price, the current owner of the benefit of all or part of a borrowing company's obligations of repayment under the terms of a given loan is willing to sell that interest (i.e., transfer to a buyer the benefit of the borrower's obligations in exchange for some consideration (e.g., an agreed-upon sum of money)). In this scenario, the current owner could be the original lender, or could be another institution (a different bank, a hedge fund, etc.) that acquired the benefit of all or part of the borrowing company's obligations, perhaps from the original lender (which may have been a bank, but which could instead have been, as examples, an individual or another type of lending institution) at a time substantially immediately following the execution of the original loan, or perhaps from the original lender or from another “downstream” entity at a later time.
Predictably, a secondary market has developed for the buying and selling of debt, including distressed debt. In some cases, a buyer may believe that a seller is undervaluing such debt, and may therefore believe that the debt could be acquired at what the buyer would consider to be a bargain price. In other cases, a seller may simply believe that a given debt is underperforming as an asset, and simply wish to recover what they can by selling that debt. In still other cases, a buyer may believe that a seller is currently more in need of having cash on hand than of having long-term, annuity-payment-making type assets, and may therefore see an opportunity to create a net positive by paying less (e.g., in a one-time, lump-sum purchase payment) than the buyer believes the revenue stream from the debt will ultimately be worth in the aggregate. And certainly many other reasons exist as to why buyers form and then act on their opinions that acquiring another company's debt would be in their interest.
Now, it often happens that companies, even so-called “good companies” (i.e., those with one or more redeeming characteristics such as well-meaning management, hard-working employees, one or more popular products, a loyal and sizeable customer base, plenty of tangible assets, etc.) find themselves in the unfortunate position of having what some would describe as a “bad balance sheet.” That is, such a company may both (a) have assets that, in the aggregate, have a high value (i.e., the company has a solid intrinsic value) and (b) have taken on more—now distressed—debt than it will be able to pay back, perhaps due to one or more runs of bad luck, one or more economic downturns, one or more inaccurate projections, and/or one or more other factors, the possible variety and composition of which are nearly limitless.
Now, it is no secret that, in this world, there are many individuals, families, universities, companies (e.g., insurance companies), endowments, trusts, foundations, pension plans, etc. that have (or at least that have control of) a great deal of private wealth. Naturally, these people, groups, institutions, etc. (hereinafter collectively referred to at times as investors, potential investors, and the like) consider it to be in their interest to invest substantial sums of money in various ways to try to, over time, increase the net worth of their holdings and/or of those they manage. As one would expect, this has created an opportunity for financially savvy individuals to go into the business of investing this private wealth (i.e., “private equity”) on behalf of these investors. Firms that conduct this type of investment, exclusively in some cases, are often known—and are referred to herein at times—as “private-equity firms.”